Historically, small-cap stocks tend to outperform large-cap stocks during the early stages of a new bull market. Growth stocks have been crushed by rising interest rates in the past year, however, and 2023 may remain a difficult environment for small-cap investors. Fortunately, there are plenty of excellent buying opportunities among small-cap stocks with potential for significant valuation upside in 2023. Investors can look to these stocks to prepare for the next economic expansion while also potentially limiting downside in the event of a recession.
Here are eight of Morningstar analysts’ top small-cap stock picks with the most valuation upside:
Tilray Brands Inc. (TLRY)
Less than five years ago, Canadian cannabis producer Tilray Brands briefly had a higher market cap than more than half the companies in the S&P 500. At the time, it would have been inconceivable to many cannabis investors that Tilray’s market cap would fall to its current valuation of about $1.9 billion. While lack of federal U.S. cannabis reform has been disappointing in recent years, analyst Kristoffer Inton says Tilray shares are extremely undervalued, and the company is well positioned to navigate a difficult Canadian cannabis market. Morningstar has a “buy” rating and $8 fair value estimate for TLRY stock.
Compass Minerals International Inc. (CMP)
Compass Minerals produces salt, sulfate of potassium and magnesium chloride. Analyst Seth Goldstein says the company’s highway de-icing salt bidding strategy should help the company’s salt segment return to profitability in fiscal 2023. With Compass shares trading for less than $50, Goldstein says investors have an excellent entry point into an undervalued small-cap stock. Compass also has a potential long-term opportunity in lithium production, a critical component for electric vehicle batteries. Goldstein estimates Compass could eventually produce 35,000 metric tons of lithium per year. Morningstar has a “buy” rating and $80 fair value estimate for CMP stock.
Pebblebrook Hotel Trust (PEB)
Pebblebrook is a real estate investment trust, or REIT, that owns upscale, full-service hotel and resort properties in or near U.S. urban markets. Analyst Kevin Brown says the company should continue to recover from its severe COVID-19 downturn and return to 2019 sales numbers by 2024. Unfortunately, he still sees potential headwinds for the business in the long term, including elevated supply and competitive pricing pressures. Fortunately, Pebblebrook has a unique portfolio of independent and boutique hotels that differentiate its properties from many competitors. Morningstar has a “buy” rating and $27.50 fair value estimate for PEB stock.
Hain Celestial Group Inc. (HAIN)
Hain Celestial produces and sells organic and natural products. Analyst Erin Lash says Hain was likely ahead of its time when it was established back in 1993. The company recently implemented a turnaround strategy that included simplifying its portfolio, expanding margins and returning to sales growth. Lash says Hain has a path to 7% annual organic sales growth by fiscal 2025 and has potential to increase profitability as it integrates acquisitions and divests low-margin businesses. Morningstar has a “buy” rating and $36 fair value estimate for HAIN stock.
Uniti is a REIT that provides communications infrastructure and solutions. Uniti’s relationship with Windstream Holdings, which is its largest tenant, makes up about 60% of its revenue and more than 80% of its earnings before interest, taxes, depreciation and amortization, or EBITDA. Analyst Matthew Dolgin says this Windstream relationship provides Uniti with reliable returns and cash flow while it continues to diversify its business and monetize its fiber assets. Dolgin says investors shouldn’t sweat Uniti’s margin contraction as its faster-growing, lower-margin fiber segment accounts for more of its overall revenue over time. Morningstar has a “buy” rating and $12 fair value estimate for UNIT stock.
Canopy Growth Corp. (CGC)
Canopy Growth is another leading Canadian cannabis producer, and it has performed even worse than Tilray. In fact, Canopy shares are down 62.7% over the past year ending Jan. 24, the worst performance of any stock on this list. Fortunately, analyst Ava Gams says Canopy’s sell-off is a buying opportunity even amid Canadian cannabis market weakness and U.S. cannabis market uncertainty. Nasdaq recently objected to Canopy’s plan to consolidate its U.S. assets into a new holding company. But Gams says a Canopy delisting is unlikely. Morningstar has a “buy” rating and $10 fair value estimate for CGC stock.
Malibu Boats specializes in designing and producing recreational powerboats. The company is the only stock on this list that outperformed the S&P 500 in the past year, declining by 4.04% through Jan. 24. Analyst Jaime Katz says the company’s innovative products and consistent pricing power created a valuable brand, and it has a strong track record of meeting evolving customer demands and rapidly rolling out new product launches. Katz says Malibu will likely continue to expand into adjacent categories, such as trailers and accessories. Morningstar has a “buy” rating and $100 fair value estimate for MBUU.
Fastly is a U.S. cloud computing services provider that specializes in helping developers extend core cloud infrastructure to the edges of their networks. Dolgin says Fastly’s third-quarter revenue beat is a sign the company is finally firing on all cylinders after operating inefficiently throughout much of the past year. He says the company’s margin expansion was particularly encouraging. Dolgin says Fastly’s stock was at one time “built on hype,” but it is now an attractively valued, high-risk stock given the company’s path to long-term success. Morningstar has a “buy” rating and $20 fair value estimate for FSLY stock.